February 12, 2001

Nasdaq Stocks Pricey Despite Drop
By Floyd Norris, The New York Times

Tech Company Earnings Sinking Fast ... Weiss comments

NEW YORK - As the red ink flows -- in a somewhat hidden manner -- the Nasdaq 100 is setting new standards for a price-earnings ratio by a major index. The index is now trading at 811 times the combined earnings of the companies in the index.

The surge in the price-earnings ratio means stocks in the Nasdaq 100 are now exceptionally expensive on the basis of the companies' ability to actually make money.

The ratio, which had never been above 165 before this year, reflects the fact that many Nasdaq companies are reporting huge losses for 2000, when their financial results are analyzed using generally accepted accounting principles, known as GAAP. That trend has been obscured, however, because many companies adjust the numbers in ways that make profits appear to be rising.

"The disparity between the pro-forma headlines that companies emphasize in their news releases and the GAAP numbers has grown enormously over the past month and a half," said Thomas Coleman, the head of research and risk management for Aequilibrium Investments, a London-based money management firm.

The price-earnings ratio is based on the earnings, or losses, of each company in the index for the most recently reported 12 months. Those numbers are weighted according to the relative weight of each company in the index, which includes 100 of the largest companies traded on the Nasdaq market.

The rapid rise in the price-earnings ratio, which stood at 127 at the end of December, does not reflect any significant change in the price of the stocks in the index since the end of the year. The Nasdaq 100 stock index ended last week at 2,261.77, down 3.4% for 2001. It is down 51.9% since it peaked in March, when the price-earnings ratio was 165, a fraction of the current ratio. Had earnings stayed the same, the price-earnings ratio would be less than half the 165 level.

Instead, the soaring price-earnings ratio reflects big losses being posted for the fourth quarter of last year by a number of companies, in contrast to profits or much smaller losses for the same quarter of 1999. Overall, profits of the companies in the index are down 90% since the index peaked.

The nosedive in profits is tied to write-offs, the largest of which appears to come from Excite@Home, the cable Internet company, which took a $4.6 billion hit. Other Nasdaq 100 companies that took large write-offs included, Yahoo and CNET.

If the cumulative write-offs become much larger in coming quarters, the Nasdaq 100 could find itself with net losses, leaving it with no price-earnings ratio at all. That would be a remarkable situation for an index that includes major companies.

The last time the Dow Jones industrial average showed a net annual loss for its companies was in 1933, at the bottom of the Great Depression. The Standard & Poor's 500 index has never had a period with net losses for all the companies.

A price-earnings ratio over 100 is incredibly high by historical standards; a price-earnings ratio of 811 is unthinkable. What that means is that it would take the average Nasdaq 100 company 811 years to earn the equivalent of its share price -- 811 years! Medical science is making great strides everyday, but I'm willing to bet that the average investor won't be around long enough to see that day come!

What's more unbelievable is that investors are still buying these outrageously priced stocks, obviously thinking the stocks are still going to go up! To be sure, not all Nasdaq 100 companies have a price-earnings ratio longer than the average life span. But, for every good company, there are many more that don't have any earnings to speak of.

And those overpriced companies are multiplying. The slowdown in the economy has ravaged the so-called new economy. Tech companies that weren't supposed to be subject to the boom and bust cycles of the "old economy" have proven to be even more susceptible to those cycles.

Even with all of the accounting gimmicks used to paper over earnings shortfalls, the rapid downturn in the economy has hammered more and more companies into negative-earnings territory. And it won't be long before investors wise up and refuse to pay such a huge premium for these loser companies.

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